Bond markets await inflation data: Jajoo

Valuations look reasonable but sentiment still remains bearish

In fixed income markets last week, while bond yields continued to edge up on inflation and tapering concerns, money market rates eased sharply on improved liquidity. Bonds opened the week on a flattish note. However, stronger than expected data in the US with the unemployment rate shrinking to the crucial 7% mark , non-farm payroll growth at above 200,000 for the second successive week and Q3 GDP growing at 3.6% and a sharp rise in US treasury yields to 2.90% in response thereof reignited fears of accelerated tapering. Even as the rupee strengthened by 1.68% to 61.42 and the current account deficit improved to a far more reassuring $5.2 bn or 1.2% of GDP vs 4.9% last quarter, the lack of open market operation support continued to induce position squaring in government bonds by traders. The rupee remained the best performing currency among its Asian peers for the second successive week aided by aggressive dollar sales by foreign banks. Benchmark 10-year government bond yield spiked 11 bps to 8.85% from 8.74% last week. Ten-year AAA PSU bond yields though hardened by only 2 bps due to strong demand from insurance and pension funds.

 
As expected, system liquidity improved further with liquidity adjustment facility borrowings reducing to Rs 7,530 crore from Rs 15,000 crore in the previous week, and marginal standing facility balances collapsing to Rs 100 crore from Rs 6,030 crore. Right from the beginning of the week, overnight rates stayed well below repo rate generating huge buying interest in short term money market instruments. The short end of the curve was easily the outperformer for the week with three month bank certificate of deposit rates falling 19 bps to 8.89% from 9.08% and one year bank CD rates falling 20 bps to 9.05% from 9.25%.

 
Markets will keenly await data on CPI/WPI and trade balances this week for further guidance. The outcome of state elections results will also provide guidance as to whether current flourish in capital flows from FIIs remains sustained. With advance tax outflows due this week and government expected to restrain expenditure to contain fiscal deficit, liquidity will likely tighten with some back-up in money market yields. On bonds, valuations look reasonable but sentiments still remain bearish. A more decisive trend will emerge once the market is able to make an assessment on further rate actions after key data releases this week.

 
Mahendra Jajoo is Executive Director & CIO - Fixed Income at Pramerica Asset Managers